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Understanding Dividend Stocks and Their Alternatives

Dividend stocks can offer regular payouts to stockholders, potentially creating an additional income stream. However, they don’t always guarantee steady returns and come with their own set of risks. Here, we explore three reasons to be cautious with dividend stocks and suggest five alternative investment options that might better suit your portfolio.

What Are Dividend Stocks?

Dividend stocks are shares in companies that redistribute a portion of their profits to shareholders in the form of dividends. These payments are typically issued quarterly, annually, semiannually, or monthly. In 2022, U.S. companies paid out more than $547 billion in dividends, according to the Janus Henderson Global Dividend Index.

Dividend stocks are more common among well-established companies that don’t need to reinvest heavily in growth. These stocks can be purchased individually or through exchange-traded funds (ETFs) and mutual funds that focus on dividend-paying companies. While they can offer stability and potentially increasing payouts over time, relying too heavily on them can pose risks.

3 Reasons to Avoid Dividend-Paying Stocks

1. Dividend Payments Aren’t Guaranteed

Dividend payments can fluctuate. The dividend yield, expressed as a percentage of the current share price, can give you an estimate of expected payouts. However, a high dividend yield isn’t guaranteed to last, especially if the company faces financial distress and decides to reduce or pause dividend payments.

2. Dividend Income is Taxable

Dividend payments are considered taxable income. The tax rate depends on whether the dividends are qualified or nonqualified. Qualified dividends are taxed at the more favorable long-term capital gains rate, while nonqualified dividends are taxed as ordinary income, which is higher.

3. Interest Rates Can Affect Dividend Stocks

Changes in interest rates can impact the attractiveness of dividend stocks. When rates are low, dividend stocks may offer better returns than safer investments like certificates of deposit (CDs) or Treasury bills. However, as interest rates rise, these safer investments may become more appealing.

5 Alternatives to Dividend Stocks

Diversification is key to protecting your portfolio. Here are five investment alternatives to consider:

1. ETFs and Mutual Funds

These funds allow you to buy bundles of stocks or bonds in a single transaction, providing automatic diversification and reducing risk compared to individual stocks.

2. Index Funds

Index funds track a specific market index, like the S&P 500, and are considered low-cost, less-volatile investments.

3. Bonds

Bonds are debt securities issued by government agencies or corporations. When you purchase a bond, you’re lending money that will be repaid with interest.

4. CDs

With a CD, you lock up your investment for a predetermined period. Upon maturity, you receive your money back with interest, though early withdrawals may incur penalties.

5. Money Market Accounts

Money market accounts earn interest like savings accounts but often come with a debit card or checkbook for easier access, combining features of checking and savings accounts.

The Bottom Line

When investing in dividend stocks, choose companies with a solid track record of increasing dividend yields. However, be aware of the risks, including fluctuating payments and tax implications. Diversifying your investments can help mitigate these risks. For any mortgage-related needs, call O1ne Mortgage at 213-732-3074. We’re here to help you make informed financial decisions.

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